EMTA SPECIAL SEMINAR: OUTLOOK FOR BRAZIL 2015
Thursday, April 9, 2015
360 Madison Avenue, 17th Floor
(on 45th St. between Madison and 5th Aves.)
New York City
3:30 p.m. Registration
3:45 p.m. Panel Discussion
Alberto Ramos (Goldman Sachs) – Moderator
Anne Milne (Bank of America Merrill Lynch)
John H. Welch (CIBC)
Ruggero de'Rossi (Federated Investors)
Dave Rolley (Loomis Sayles)
5:00 p.m. Cocktail Reception
Support provided by Bank of America Merrill Lynch, CIBC and Goldman Sachs.
Registration fee for EMTA Members US$75 / US$695 for non-members.
EMTA NYC Panel Contrasts Brazil’s Petrobras Scandal with Well-Received Appointment of Finance Minister
A standing-room only crowd attended EMTA’s Special Seminar on Brazil, held at EMTA’s midtown New York office on Thursday, April 9, 2015. The event was made possible with the support of Bank of America Merrill Lynch, CIBC and Goldman Sachs. Alberto Ramos (Goldman Sachs) moderated the session, and led speakers through a discussion of Brazilian economic and political challenges, as well as the on-going Petrobras scandal.
John H. Welch (CIBC) described Dilma administration policies as a “lighter version of what Brazil did in the 1970s, when they ran the country into the ground.” Left with no alternatives, the President had wisely appointed Finance Minister Levy and Planning Minister Barbosa, but the political situation was quite complicated as the President’s own PT party would oppose their initiatives.
Welch added that there will be a “three-ring circus” in Brazil in the coming months, not only due to affaire Petrobras, “but because of other scandals you don’t yet know about—in the railroads, the Brazilian tax authority, BNDES and even three large state pensions which have run a deficit over the past three years.” On the other hand, Welch noted that he had become more constructive on Brazil though he was not ready to recommend it, noting among other factors that inflation was peaking and tightening monetary policy will support the BRL. “I do think we will get some decent recovery in Brazil next year,” he concluded.
Corporate bond expert Anne Milne (Bank of America Merrill Lynch) pointed out that slower economic growth would hurt domestic demand, and thus be negative for many Brazilian firms. The weaker BRL was also a short-term negative factor for the majority of Brazilian corporate issuers.
“After four years of disastrous economic policy, the President has come up with a huge positive shock in her appointment of Minister Levy, and the Central Bank hike was a positive shock too….but these were stopped because of the Petrobras scandal, and this uncertainty overhangs everything,” asserted Ruggero de’Rossi (Federated Investors). He added that, in an environment of low growth and falling confidence, the appropriate policy mix was one of fiscal tightening and monetary easing. Finally, a resolution of the Petrobras investigation was a prerequisite for greater investor optimism on Brazil.
Loomis Sayles’ Dave Rolley, the self-described “token crossover investor” on the panel, lamented that Brazil was likely to face its worst GDP growth in 25 years, with a contraction of 1.5% in GDP possible this year. “For the first five years, policymakers could have done the right thing but didn’t want to; now they want to do the right things, but we don’t know if they can,” he stated.
Moderator Ramos concurred that Brazil now had a “super credible Finance Minister, but he doesn’t walk on water; he will be challenged to deliver a significant adjustment against a backdrop of declining real activity and complex political reality.” Ramos thought a 1.2% primary fiscal surplus was possible, although he warned that the quality of the adjustment could be poor if skewed excessively towards tax hikes and large cuts in public investment. Welch noted he was not yet convinced this target was achievable.
Rolley expressed disappointment that Brazil had little to show for the commodities boom of prior years. “They took the terms of trade gift and spent it; most of it was consumed…now they are going to have to channel their ‘inner Germany’…and crush domestic demand,” he asserted.
Brazilian corporations were no longer the lowest cost producers in the commodity business, and had overextended themselves according to Milne (who underscored that most companies had leverage of over 3 times, with the average gross leverage now being 4.8 times, excluding Petrobras which is over 5 times.) The weaker BRL and softening commodity prices were other concerns, while, on the positive side, most companies had high liquidity and non dollar-generators had largely hedged their interest rate exposures. She saw the pulp and paper and protein sector as likely outperformers.
If Petrobras can’t produce its audited financials by April 30th, Milne expected credit downgrades and a potential technical default. Any bond acceleration would be a “huge negative for both Petrobras and Brazil,” she stated. Petrobras needed a scaled-back business plan and higher domestic prices (due to the majority of their output being sold domestically).
In Milne’s view, the market had priced in most of the good news but little of the bad news, and she believed Petrobras should be downgraded to sub-investment grade. De’Rossi provided a contrasting view, stating that the market was pricing in a 30% chance of a technical default, and suggesting that the market was in fact pricing in some of the potential negatives.
Moderator Ramos and de’Rossi concurred that fair value for the BRL was 3.1 to 3.2, with Ramos stating that the currency could well move towards a weaker level of 3.4 to 3.6 (“having a somewhat weaker than fair-value currency is quite frequent in the initial stages of a macro adjustment”) and de’Rossi seeing 3.0 possible if the Petrobras affair was put to bed in a positive way. Rolley commented that the government needed to continue to let the BRL be a shock absorber.
Rolley warned the audience not to be complacent at the potential effects of credit downgrades to either Brazil or Petrobras. “Many large accounts, sovereign-wealth type size, have given investment-grade only mandates; and you will find many haven’t already sold their bonds if Brazil or Petrobras gets downgraded [below investment grade],” he affirmed. Milne speculated that a downgrade of Petrobras could lead to a forced selling of up to $5 billion in the corporation’s external debt.
The panel discussed how to trade Brazil. For Rolley, in an era of low oil prices, and a wide variety of additional corporate investigations, Brazilian equities might be an interesting trade, with Brazilian oil a potential contrarian recommendation. Milne favored the middle and long end of the curve for corporates for the biggest pick up over Brazilian sovereign debt.
Panelists concurred that an impeachment of President Dilma, despite the country’s loose definition of what could lead to removal of a President, was not in the interest of the opposition. Instead, speakers agreed that political opponents would prefer that Dilma absorb the cost of lower living standards.